Tax Issues Involving Mortgage Debt Forgiveness

Steven J. Fromm

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Tax Lawyer - Philadelphia, PA

Contributor Level 20

Posted over 3 years ago. 2 helpful votes

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1

Principal Residence Exception Allows Exclusion of Up to $2 Million

Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2

Married Filing Separately Exclusion is $1 Million

The limit is $1 million for a married person filing a separate return.

3

Mortgage Restructuring Is Covered Under The Above Exclusion

You may exclude under the above rules debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4

Debt Must Have Been Used to Buy, Build or Substantially Improve Primary Residence

To qualify, the debt must have been used to buy, build or substantially improve your principal residence.

5

Debt Must Have Been Secured By Residence

To qualify, the debt must have been secured by the primary residence.

6

Refinanced Debt Proceeds Must Be Used to Substantially Improve Principal Residence To Qualify for the Exclusion

Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion. Proceeds of refinanced debt used for other purposes - for example, to pay off credit card debt - do not qualify for the exclusion.

7

File Form 982 with Form 1040

If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8

Second Homes, Rental Property, Business Property, Credit Cards, Car Loans Do Not Qualify

Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions - including but not limited to insolvency, bankuptcy - may be applicable. IRS Form 982 provides more details about these provisions.

9

Form 1099-C Will Report Cancellation of Debt

If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed. Be sure to examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

Additional Resources

IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments.

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Debt

There are different types of debt, but all involve one person (the debtor) owing money to another (the creditor). Terms of repayment are governed by a contract.

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